The slowing U.S. economy and the falling dollar will be among the hot issues in this weekend’s G-7 meeting in Tokyo, where finance ministers and central bank chiefs will discuss ways to stabilize the global impact of the U.S. subprime crisis. The topic of China’s inflexible currency regime will be bumped off center stage, as the leading economies mull the use of integrating fiscal easing to monetary polices, an idea that was backed by IMF Chief Strauss-Khan. But there are tensions already as Germany and Canada remain reluctant to ease fiscal policy, demanding that the United States do more via fiscal and monetary stimulus as the source of the global woes remain specific to the United States.
European finance ministers will likely demand some cap on the rising euro, but U.S. policy makers remain opposed to the idea of any calls preventing continued dollar weakness. The same applies to the strengthening yen where Japanese officials may have concerns with a soaring currency at a time when Japan is seen slipping into recession. On the policy front, there are rumors regarding a possible resignation of French Finance minister, to which the ministry responded with no comment. Last week speculation swirled that ECB member and Bank of France Chief Noyer would lose his job over the Societe General fiasco.
While San Francisco Fed President Janet Yellen made the unusually sanguine remark from a central banker indicating she is “not confident” the United States will avoid recession, other Fed members are rebalancing the rhetoric and paying more lip service to inflationary pressures as was seen this week regional Fed chiefs Plosser and Fisher. Yet this is not altering market’s expectations of 50 to 75 more basis points (bp) in rate cuts from the Fed this year. We expect another 100 bps for the year, lowering the fed funds rate target to 2.00% by year-end.
Further yield curve steepening reflect stagflation light
We had been referring to the continuous steeping in the U.S. yield curve as the basis for our interest rate calls, which has now increased to a four-year high of 170 bps in the 10-/two-year spread. Unlike in past weeks when the steepening was largely due to prolonged declines on the short end of the curve, with two-year yields falling to as low as 1.87%, the long end is now being pushed by inflationary concerns. This was manifested in yesterday’s poor 30-year auction, which generated an awarded yield of 4.40%, resulting from poor participation from foreign bidders. This suggests that foreign bidders’ interest in U.S. long-term bonds is dwindling due to dollar weakness as well as deteriorating inflationary conditions.
Euro’s biggest weekly loss in 18 months
The euro is set to post its biggest decline against the dollar in 18 months after ECB’s Trichet dismissed the notion of an economic decoupling between the United States and Europe, suggesting that the Euro zone be impacted and possibly require lower interest rates. We expect further euro losses next week when the ZEW investment survey is expected to show deepening pessimism by German financial market participants. We reiterate that our $1.45 month-end forecast does not rule out lower levels before the end of the month, with a considerable possibility of the $1.43 being tested. Resistance is brought down to $1.4550 from $1.4660, while downside target stands at 1.4400, backed by key foundation at 1.43.
Loonie’s flies on Strong Jobs
The Loonie rallies across the board after Canada’s payrolls rose 46,400 in January from -18,700, overshooting expectations of a 10,000 rise. The unemployment rate drooped to 5.8% from 5.9% surprising market consensus of a rise to 6.0%. USD/CAD is seen extending losses towards 0.9950, while GBP/CAD and EUR/CAD are seen as the greatest losers in the aftermath of the data.
Sterling’s bounce remains limited
The pound extended losses towards the $1.94 figure after the Bank of England statement rate cut confirmed market’s expectation of gradual easing ahead. This was further highlighted by the UK-based National Institute of Economic and Social Research decision to estimate for a 0.5% GDP growth in the three months through January, the lowest pace since 2005. This follows 0.6% in Q4, backed by 1.9380. While we warn of a rebound to as high as 1.9560 next week in light of poor U.S. data, we continue to expect renewed losses for the currency across the board. We expect a retest of the January low of $1.9330, and 204.50 in GBP/JPY.
Yen downside seen limited
Yesterday’s gains in USD/JPY were partly triggered by Dallas Fed president Fisher’s warning against disregarding the inflationary risks to the U.S. economy as he touched upon his decision to not vote for a rate cut at last week’s FOMC rate cut. The yen remained lower across the board as U.S. stocks held on. The 107.80 resistance has acted as a key resistance seen for the past three weeks and is expected to do so as long as downside continues to act on U.S. equities and risk appetite.
We expect key resistance to stand at 108.20 into next week, while support crops up to 107.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
